Prop. Regs on Predeceased  Parent Rule

The IRS issued proposed regulations (REG-145988-03, 9/3/04) on the predeceased parent rule that (1) make it easier to apply and (2) provide guidance on its application in particular situations. These regulations are important, because an automatic allocation of generation-skipping transfer (GST) tax could use exemptions not required. Code Chapter 13 imposes a tax on all transfers, whether made directly or indirectly, to skip persons (generally, a person two or more generations below the generation of the transferor or a trust, if all of the interests in the trust are held by skip persons). Transfers subject to GST tax are direct skips, taxable terminations and taxable distributions.

Overview

The Taxpayer Relief Act of 1997, Section 511(a) and (b)(1), repealed former Sec. 2612(c)(2) and replaced it with Sec. 2651(e), which assigns individuals to generations for purposes of the GST tax. Sec. 2651(e) broadens the predeceased parent rule by expanding its application to transfers (1) that would be taxable distributions or taxable terminations and (2) to collateral heirs, provided that the transferor has no living lineal descendants at the time of transfer. Sec. 2651(e) applies to terminations, distributions and transfers occurring after 1997. It does not apply to a transfer to an individual who is not a lineal descendant of the transferor or his or her spouse, if at the time of the transfer, the transferor has any living lineal descendants.

Established or Derived

One issue addressed by the proposed regulations relates to the time when an interest is established or derived. Prop. Regs. Sec. 26.2651-1(a)(3) provides that an individuals interest in property or a trust is established or derived at the time the transferor is subject to tax under Code Chapter 11 or 12. If the transferor is subject to transfer tax under Chapter 11 or 12 on more than one occasion, the individuals interest will be deemed established or derived on the earliest of those occasions.

Exception for QTIPs

However, there is an exception in Prop. Regs. Sec. 26.2651-1(a)(3) for remainder interests in trusts for which a qualified terminable interest property (QTIP) election has been made under Sec. 2056(b)(7). Specifically, to the extent of the QTIP election, the remainder beneficiarys interest will be deemed to have been established or derived on the death of the transferors spouse (i.e., the income beneficiary), rather than on the transferors earlier death. Absent this exception, a remainder beneficiary of a QTIP trust would not benefit from the predeceased parent rule if his or her parent is alive when the QTIP trust is established, but deceased when the income beneficiarys interest terminates.

Reverse QTIPs

However, under Sec. 2651(e), the rule does not apply to any trust for which a reverse QTIP election has been made. If a reverse QTIP election is made, the grantor remains the transferor of the trust for purposes of Code Chapter 13. In most cases in which a reverse QTIP election is made, GST tax is allocated to the trust so that it will be exempt from GST tax when established.

From Jeffrey B. Jackson, CPA, Sol Schwartz & Associates, P.C., San Antonio, TX